IMF warns about a’shadow banking’ crisis

The International Monetary Fund stated that governments must tighten regulations for pension schemes, investment funds, and insurers to prevent a new financial crisis.

The fund called on regulators to “robust supervision, regulation, and supervision” of so-called shadow banks ahead of its spring meeting of central bankers and finance ministers in Washington next week.

Officials from the IMF pointed out last autumn’s collapse in UK risk-driven investment schemes as an example of how financial stability could be shaken by sudden movements in the price and interest rates.

The financial system’s less regulated areas are being monitored by policymakers for potential threats. These include institutions that have taken on large amounts of debt, and whose assets (including bonds) have seen a plunge in value in the past year. After three US lenders went bust last month, they are now the first to be hit by rising interest rates.

According to the IMF’s blog on financial stability, the recent banking panic was “a stark reminder of pockets of high financial vulnerabilities built over many years of low rates and compressed volatility and ample liquidity”. These risks could increase in the coming months due to global tightening of monetary policies. It is important to understand and protect this wide swathe, which includes a variety of institutions other than banks.

Last week, the Bank of England issued a similar warning. It highlighted the rapid growth of private lending markets that include entities like hedge funds and private equity companies. These people borrow money with financial instruments that have higher interest rates. When financial firms cannot sell their assets quickly enough in order to raise funds during market turmoil, they can be in serious trouble.

According to the IMF, central bankers face a “challenging choice” between managing inflation with interest rates and making sure that higher borrowing costs don’t trigger panic in financial markets.

The authors stated that clear communication was crucial to ensure liquidity support is not confused with monetary policy.